Retirement Account Rule Changes in Response to COVID-19

The coronavirus pandemic has caused massive disruption to everyday life, as millions of Americans are struggling to cover themselves financially in the fallout. In response, the federal government has passed an unprecedented amount of stimulus, much of it in the form of direct payments to citizens. While the $1,200 checks and unemployment benefits absorb most of the headlines, the CARES Act did include some additional relief for those who contribute to qualified retirement accounts. Here’s what you need to know about retirement account rule changes in response to COVID-19.

If you need assistance with your finances, work with a professional financial advisor from Good Life Financial Advisors of Mt. Pleasant. We’re ready to help create a personalized plan for your specific needs.

Relief for 401(k) and IRA Account Holders

The new coronavirus relief legislation makes it possible to avoid the 10% early withdrawal penalty if you’re under the distribution age of 59.5. According to the CARES Act, retirement savers with a 401(k) or traditional IRA account can now access up to $100,000 of their nest egg without being penalized OR taxed. Well, at least not immediately.

The $100,000 number is the upper bound on withdrawals, but there’s no minimum account balance required. If you have less than $100,000 in an IRA or 401(k), you can withdraw every cent if you’d like. And you don’t even need to take it all out at once. Qualified accounts can be tapped multiple times as long as the total balance of withdrawals doesn’t go over $100,000. Additionally, there are no restrictions on what these distributions can be used for. If you have a handle on your bills, you can use coronavirus-related distributions to pay down credit card or student loan debt, for instance.

To withdraw money from your retirement account, you’ll need to prove you’ve experienced some type of hardship due to COVID-19. A positive test from a CDC-approved facility would qualify you, as would any of the following:

  • Being laid off or furloughed
  • Reduction in work hours or wages
  • Unable to work due to lack of child care
  • Place of business forced to close
  • Living with or caring for a spouse or family member with a positive COVID-19 test

If you meet any of these conditions, you could have the standard 10% early withdrawal penalty waived. You’ll still owe income taxes on any distributions, but the CARES Act makes that burden a little easier to handle as well.

Extended Tax Payment Terms

When you withdraw from a 401(k) or traditional IRA account, you’ll owe income taxes regardless of your age. The 10% early withdrawal fee might be going away, but you won’t avoid the IRS completely. Even so, there is still some relief. Here’s where the new legislation comes in: the income taxes owed on COVID-19 retirement account distributions can be paid over a period of three years. Instead of owing the full amount on your next tax bill, you’ll have 36 months to settle your tab with the IRS.

Your clock starts the day after you take out the money, but the structure of your payment is up to you. You can wait until the very end of the 36 months and pay all at once, or you can space things out and pay a portion of your tax obligation each year.

Enhanced 401(k) Loan Terms

If you don’t feel like breaking open your nest egg, you can now borrow against it with much better terms. Loans are banned when using IRAs, but 401(k) accounts allow savers to borrow $50,000 or 50% of their account balance at a reasonable rate. Most 401(k) loans are repaid within five years.

With the CARES Act, 401(k) loan terms have changed. 401(k) holders can now borrow 100% of their balance or $100,000, whichever amount is smaller. You’ll also get an extra 12 months to repay any 401(k) loans—but remember that loans will still require interest payments.

Catching Up on Contributions

If you withdraw money from your 401(k) or IRA to help with financial difficulty caused by the pandemic, you’ll be able to return it without worrying about contribution limits. If you take $100,000 out of your IRA in 2020, you’ll be eligible to return that $100,000 to your account within three years. Returning a distribution doesn’t affect your usual contributions limits either. You can still put in $5,500 each year on top of returned distribution. Here are a few other new rules regarding contributions and distributions:

  • The deadline for 2019 IRA contributions is now July 15, 2020. If you haven’t maxed out your IRA for 2019, you still have a chance to do so.
  • Required Minimum Distributions (RMDs) can be skipped in 2020 for qualified account holders. After age 72, savers are usually required to withdraw a certain amount of money each year. The CARES Act waives this stipulation in 2020.

Retirement Funds Should Be for Emergencies Only

If you’re struggling with personal cash flow and think liquidating a retirement account is a good idea, consider the downsides before immediately tapping the funds. The market is still far off from its February highs, and savers taking distributions now are committing one of the cardinal sins of investing—selling low.

Work With an Experienced Financial Advisor

The best personal finance decisions are in the eye of the beholder. A computer programmer who can work from home probably will avoid withdrawing funds from a retirement account, but a laid off airline worker might have no alternative. That said, if you must use retirement funds to make ends meet, be sure to follow the guidelines laid out in the CARES Act to avoid paying unnecessary taxes and fees. If you need assistance or have any questions, don’t hesitate to reach out to a team member at Good Life Financial Advisors of Mount Pleasant.